The Concept of Value Added

In the business world, there is a direct relationship between businesses. All businesses rely on each other to supply the necessary intermediate goods for production to take place. This is known as interdependence.

All products are made from a combination of the following 3 ingredients:

1) Natural resources (commonly referred to as raw materials) are the resources supplied directly by nature. Everything produced must start with these resources. Examples include: timber, mineral resources, crops and seafood products.

2) Capital resources are the human made objects that help in producing other products. Examples include: machinery, buildings, technology.

3) Labour resources include all the skills and effort both physical and mental that humans put into the production process.

Production therefore refers to the activities undertaken by the business that combines the above factors of production to make final products available for human use.

For example: to make a cake you would require eggs and flour (natural resources), beaters, bowls and ovens (capital resources) and skills and effort to bake the cake (labour resources.)

Through each stage of the production process value is being added. Consider a loaf of bread:

1) The farm grows the wheat. Seed, soil and water are the natural resources. The tractor and harvester are the capital resources. The farmers time and energy represent the labour resources.

2) Next the wheat leaves the farm and travels to the silo. Transport companies are hired to transport the wheat from the farm to the silo.

3) The wheat is then converted to flour at the flour mill. The flour is bagged and then transported to the bakery where the flour can now be used to bake the bread.

4) The bakery now uses the flour to bake the loaves of bread. Transport companies are then used to transport the bread from the bakery to the supermarkets.

As raw materials move to various stages of the production process and are changed into intermediate products, value is being added. The value added to the product is the difference between the cost of the raw materials bought from outside the business and the amount received from the customer.